A company's operating ratio gives an indication of what percentage of net sales is used to pay for the cost of goods and overhead. The lower the ratio, the more money is available to pay off debts or to invest into the business.
The operating ratio is found using the following formula:
Cost of Goods Sold (COGS) + Operating Expenses
Operating Ratio = ------------------------------------------------
Net Sales
The cost of goods sold or COGS is found from the cost of goods available for sale, minus the cost of the ending inventory.
An operating ratio of 0.5:1, for example, indicates that fifty cents on every dollar come to you as cash which may be used to pay off debts or expand business. An operating ratio over 1:1 (say, 1.25:1) indicates that a business' sales do not cover its expenses.
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